In their 2008 whitepaper, “Why IPOs are in the ICU,” (BVWire™# 75-3), authors David Weild and Edward Kim (both from Grant Thornton) charted the slow demise of the IPO market. The pair recently updated their study in “Market Structure is Causing the IPO Crisis.” Among their current findings:

The IPO crisis has worsened. “The first six months of 2009 represents the worst IPO market in 40 years.” During that time, only 12 companies went public in the U.S. (and only eight of these were U.S. companies). The median IPO was worth $135 million, compared to twenty years ago, when it was common to close IPOs at $10 million. “Given that the size of the U.S. economy, in real GDP terms, is over 3x what it was 40 years ago, this is a remarkable and frightening state of affairs.”

Main Street is hurting. Historically, up to half of all IPOs involved enterprises outside the VC or PE realm. “The lack of an IPO market is thus hurting small business by cutting off a source of capital that in turn would drive [local] reinvestment and entrepreneurship.”

Market structure is to blame. A “perfect storm” of factors caused the current IPO crisis, consisting of uncoordinated regulatory changes, the emergence of online brokers, and the decimalization of the U.S. securities exchanges—“all of which stripped away the economic model that once supported investors and high-quality research.”

As a result, the public markets operate a form of “casino capitalism,” the authors say, that caters to high-frequency trading at the expense of long-term investors. Their radical solution to the broken legacy system: an “opt-in” stock market, subject to SEC oversight and run separately or as a segment of the NYSE or NASDAQ. Or will a secondary market for private securities (as reported last week’s ‘Wire) offer a platform for “private” IPOs? Consider: Pluris Valuation Advisors just announced a new Palo Alto office and the launch of Pluris DLOM Database™, based on data collected from private sales of illiquid securities. Stay tuned…

‘Levered DCF’ falls to Daubert

Daubert challenges to financial experts are de rigueur; at least half a dozen new cases came in this month, each attacking the relevance and reliability of the valuation evidence (or the valuator’s qualifications). Daubert motions now play the same role as depositions: both “try” the evidence—and exact costs from an opposing party—prior to trial.

In some of the more complex bankruptcy and securities litigation cases, however, Daubert challenges test what appear to be “standard” methods, from proven experts. For example, an otherwise qualified expert valued a Chapter 11 debtor under a “levered” discounted cash flow (DCF) approach. The method simply adjusted the typical DCF elements to fit the debtor’s reorganization plan, the expert said. Specifically, he assumed zero projected cash flow until the debtor’s proposed sale in 2012, at which point he subtracted net debt and preferred stock (labeling this “terminal value”) and applied a discount rate (determined from cost of equity) to reach an equity value.

Although the expert may have used traditional terminology, there were “no substantive similarities between the generally accepted DCF method” and his “levered” method, the federal bankruptcy court found. Further, the expert made “multiple novel assumptions,” such as an assumed sale of the company, and a discount rate that failed to account for both the cost of debt and equity. It may have met the facts of the case, but his method failed to match the “intellectual rigor” required of an expert valuation, and the court disqualified the untested approach under Daubert. Read the complete digest of In re Young Broadcasting, Inc. (S.D.N.Y., April 19, 2010) in an upcoming (June 2010) Business Valuation Update™; the court’s opinion will also be available at BVLaw™.

Weston Anson: IP now represents the largest portion of the value of most companies that require valuations

In a recent article in the ABA’s YourABA, Weston Anson (CONSOR) was asked why IP valuation is attracting so much attention suddenly. Anson, the author of IP Valuation and Management, answered: “I was just at a conference that brought together 200 leading experts in the field of intellectual property. One of my compatriots pointed out that consistently over the last two decades, the value of IP and intangible assets has held very steady at about 60 percent of the value of an entity…this in turn means that every transaction, litigation or arbitration” is likely to be composed of at least 50 percent intangible assets.

And it’s just not the arts or design companies any longer: Anson comments that “IP is ubiquitous and it covers everything, including…t-shirts for movies, to pharmaceuticals to collectibles at the Grand Canyon.”

Merger and acquisition activity in the first quarter of 2010 “started off slower than expected,” reports Mike Rosendahl (PCE Investment Bankers) in his quarterly State of the M&A Markets. Transaction activity decreased in all valuation segments, however valuation multiples increased substantially in every segment except for transactions below $50 million. This “appears to bolster the case that there is a flight to quality for larger transaction and also highlights the number of distressed deals that are closing. Distressed transactions tend to trade at high multiples, but low values,” says Rosendahl.

On a brighter note: “One of the few good things about a recession is that it provides a chance to reconsider basic valuation assumptions affected by the depressed economic environment,” writes R.J. Dragon in his blog RJ on BV. “Business valuation experts can get a quick update by reviewing some of the popular references in our profession. So when the 2010 edition of Mergerstat Review arrived, it was time to see how things changed in the “Great Recession” of 2009.”

Here are some of the Dragon’s analyses:

It appears that many sellers of privately-held companies are not keeping companies “off the market” waiting for a return to pre-recession valuations: The sale of privately-held companies is still the biggest category of M&A transaction, accounting for 51% of acquisitions in 2009 versus 55% in pre-recession 2007.

Control premium rises when earnings are depressed and drops in boom years: Control premiums in this recession have risen to approximately 40%, the level also seen in the 2000-2001 recession.

Private equity is a major force in the markets and a determinant of business value: private equity firms are still winning a larger percentage of larger deals.

Among other reasons, Hooke points out why experts should read this practitioner-oriented book: "Two market crashes -- and the attendant fallout -- suggest that business appraisers consider the use of higher discount rates, the need for recessions in many forecasts, and the inclusion of political risk in certain US business evaluations.""The validity of each methodology -- be it guideline companies or discounted cash flow, to give two examples -- has to be cross checked against its counterparts now more than ever, or the appraiser can get false readings."

Damodaran on the Goldman Sachs indictment:
“mixed feelings”

“While I understand the urge to bring the mighty back to earth, I think that failing to support Goldman at this time is a huge mistake,” admits Professor Aswath Damodaran (NYU Stern School of Business) in his blog Musings on Markets. “To me, this case reveals everything that is wrong with both politics and law - the use of ex-post evidence to back up a case (Paulson made money of the housing crash.. so, he must have known that the crash was coming), suspicious timing (just in time for the new law on regulating bank) and scapegoating,” he says. Still, he’s right—appraisers deserve to take a certain pleasure in watching the whole episode.

Valuing construction companies: key information for
BV experts

The construction industry has been a large source of valuation work over the years, but the industry has been hit hard by the recent recession and “housing bubble.” On May 13, valuation experts Don Drysdale (Drysdale Valuation) and Keith Prescott (Wisan, Smith, Racker & Prescott, LLP) will examine the tools and considerations needed to value a construction business in this tumultuous economic climate. Click here to register.

Free downloads continue to be popular withBVWire™ readers

BVR provides over 90 free articles, papers and standards written by top experts in the field of business valuation.

The full text of Holman v. Commissioner, 8th Cir. (April 7, 2010) was the most recent addition to the list of free downloads. Look for an analysis of the case in the next (June 2010) BV Update.

What are you saying about the future of the economy in
your reports?

There’s certainly enough to complain about. For example, there’s this: “Our generation is on the verge of dooming the United States to second class status unless we change our ways dramatically and soon,” says Dr. John W. Mitchell, quoting Chris Varvares, past president of the National Association for Business Economics. In a presentation at last week’s Kruse Way Economic Forum, Mitchell, former Economist for US Bank, reported that the U.S. lost over 8 million jobs in this recent recession and that it may take 4-5 years to get back to pre-recession employment levels. Mitchell also said that only three States are showing positive job growth: Alaska, North Dakota and New Hampshire.

How are you interpreting and integrating the long-term economic forecasts into your business valuation reports? Share your perspective with the BVWire editor here.

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